Assessing economic effects of foreign aid and capital flows on real economic growth

Abstract

The study sought to investigate the effect of foreign aid and capital flow on real economic growth for the SADC region. Eleven member states of the SADC region are selected for analysis based on data availability. In the study, foreign aid is represented by official development assistance (ODA), external debt (EXTD), and debt service cost (DSC) while the inflow of foreign direct investment represents capital flow (FDI). Annual percentage growth of per capita Gross Domestic Product (GDPpc) is used as a proxy of real economic growth. Trade balance (TRO) is included in the model regression as a control variable. The study employed panel econometric models. The results of panel ARDL indicate that ODA and FDI were found to have a negligible effect on real growth in the short run but contribute positively and significantly in the long run. This revelation supports the view that ODA and FDI are essential determinants of growth. On the other hand, EXTD together with its associated costs was found to have a detrimental effect both in the short run and long run. Based on the results of the study, the authors put forward the following policy recommendations for the SADC region: most importantly, there ought to be effective management of external debt by SADC countries to reduce their overdependency on external debt for their domestic needs. Given the positive effect of FDI in the region, the SADC region needs to intensify its efforts in devising measures that will attract foreign investors to the region which among others include pursuing inclusive and sustainable economic growth. Lastly, there is a need for effective management and official development aid to ensure sustainable growth.